THE GLOBAL BULLION TRADE 24 April 2009 Determining the bullion price: The London Gold Price The price of bullion is fixed twice daily, London time at 10:00am and 15:00pm, by a consortium of five of the worlds biggest banks; an arrangement which has been in existence since 1919. Currently the rotating table is made up of – Bank Nova Scotia – Scotia Macalta Barclays Bank plc Deutsche Bank AG HSBC Bank USA NA Societe Generale The proceedings are routine and begin by the chairman suggesting an opening price and then nets all orders which have been placed with the banks. Throughout this process, members may adjust orders by raising a flag; the final price will not be set until all flags are down. The bullion trade The demise of the gold standard along with post war Bretton Woods arrangement has not tarnished the role of gold in international banking despite central banks reducing their gold deposits (prior to the Washington Agreement). Indeed several central banks have indicated their desire to increase their holdings of gold (including China and Russia) in as an alternative to dollars which has been the main anchor of international reserves since the collapse of Bretton Woods (beginning 1972) despite continuing inflation in the United States and the resulting decline in value of the US Dollar viz alternative currencies primarily due to monetary overhang resulting in record deficits on the trade account (peaking at over 7% in 2008) and budget. The Washington Agreement on gold Following the pre – announcement by the bank of England (BoE) to dispose of 58% of its gold reserves in a series of gold auctions, gold producers managed to bring major central banks to the negotiating table whereby an agreement was reached whereby both producer and the central banks desired to bring some form of stability to the gold price which had been under pressure for several years. It should be noted that the gold price changes more in relation to sentiment than to changes in production given the huge quantity of stored gold. Current annual output is around 2 500 tons per annum (according to the World Gold Council) with increasing proportion of output coming from so called new producers, including China & Peru, and declining output from traditional producer, South Africa. In any event, the agreement reached limited annual central bank bullion sales to 500 tons per annum and a maximum sale of 2000 tons for the period September 1999 to September 2004. The Gold Antitrust Committee The Gold Antitrust Committee (established in January 1999), which seeks to bring transparency to the gold industry, and in particular identify price manipulators (as a means of explaining the depressed gold price of the gold during the course of the 1990's portrays a very different story which is worth looking at - It explains the depressed gold price during the course of the 1990's to the conduct of central bank policy whereby gold would be leased to privileged bullion banks in order to suppress the price of gold and in doing so, bolster the value of their national currency's. Through the Washington Agreement of Gold, Central Banks are able to account for gold which they no longer had possession of. These bullion banks were not required to return the bullion by buying gold on the open market – this action would be self defeating in that it would cause the value of currencies to fall. Therefore, the WAG allows central banks to sell their gold to bullion banks which in actual fact already leased the gold in the first place. Factors effecting the gold price The ability of central banks to print money at will and the belief that inflation – albeit low inflation – is a necessary condition for economic growth will continue to attract investor interest in gold given the precious metals defining characteristics, namely scarcity and general desirability. In addition to the continuing role of gold in the financial system, the metal has several industrial applications including jewelry. It is exceptionally difficult to determine where demand for the metal arises, not least of all because one cannot say if gold jewelry – which traditionally constitutes a large portion of annual gold demand – should be classified as an industrial application or an investment. It should be noted that India remains the world’s largest importer of the metal, the bulk of the metal is used for jewelery related to religious reasons and literally exits the gold cycle. Atempts by New Delhi to usurp this demand, which is felt to be an unnecessary burden on the balance of payments, have all been unsuccessful. Even amongst peasant populations throughout the world, the protection that gold offers against hostile government policies is not lost. The high gold prices witnessed since the turn of the century bull run has all but evaporated demand for jewelery and industrial demand (demand in dentistry has been falling for many years and is now almost obsolete due to cost and changing styles) is limited to all but the most advanced applications in electronics. High prices have clearly been driven through safe haven buying – demand was up 64% from investment funds for 2008 compared to the previous year - from investors seeking refuge from negative interests, inflationary expectations and from general insecurity given the turmoil in financial markets. As mentioned earlier, central bank gold sales are now limited by the Washington Agreement; indeed, central banks may now very well considering the wisdom with high and sight behind the sales and for good reason too. State of the South African gold mining industry Overall the industry is one in decline having peaked in 1970 (at 100 tons for the year) output has steadily declined with the relative portion of global output falling even faster. From 75% of free world production in 1975, the Republic is now only producing a mere 8% and that share is falling rapidly as production increases from low cost producers including China, Australia, Canada, Philippines, Peru, China, Mali and the United States. Several factors have brought about the demise of the local gold mining industry including the cost of labor (amongst the most expensive in the world), declining ore grades and the ever increasing depths needed to extract the ore. The exchange rate which has rapidly appreciated in relation to our major trade partners beginning 2001 despite the republic having a consistently higher inflation rate has severely undermined the mining sector, including the gold industry. The great commodity boom which began in 2000 has by and large by passed South Africa all together. Of the major local gold producers, Harmony Gold (HAR) is particularly geared to the Rand exchange rate and its share price has suffered relatively to its competitors, including Goldfields (GFI) and Anglo Gold (ANG).